Practice Note No 04/2004 Date of Issue 15th December 2004 ... - TRA

Practice Note No 04/2004Date of Issue 15 th December 2004INCOME FROM BUSINESS1.0TAX LAW.This Practice Note applies in respect of the taxation of income from business.2.0 INTERPRETATION.In this Practice Note, unless the context requires otherwise –“Act” means the Income Tax Act, 2004.Definitions and expressions used in this Practice Note that are used in the Acthave, unless the context requires otherwise, the same meaning in this PracticeNote as they have in the Act.3.0 THE APPLICATION OF THIS PRACTICE NOTE.This Practice Note considers: -3.1 Activities constituting business.3.2 Receipts deemed to be gains or profits from a business.3.3 Claim of right to derive income or incur an expenditure3.4 Reverse of amounts3.5 Deductions from business income.3.6 Amounts not deductible from business income.3.7 Capital gains and losses.3.8 Carry forward of losses.3.9 Donations.

0.0 HOW THE LAW APPLIES.0.1 Activities constituting conducting a business.“Business” includes a trade, concern in the nature of trade, manufacture,profession, vocation or isolated arrangement with a business character;and a past, present or prospective business, but excludes employmentand any activity that having its nature and the principal occupation of itsowners or underlying owners, is not carried on with a view to derivingprofits.Income from business is calculated as follows:-Amounts derived from conducting the businessDeduct any payments which have been subjected to a finalwithholding tax.Deduct depreciation allowanceDeduct or Add depreciation balancing adjustmentsDeduct trading stock allowanceAdd net capital gains (after deducting capital losses)Deduct any loss carry forward from previous yearDeduct donations.0.2 Receipts deemed to be gains or profits from a businessAmount treated as gains or profits from a business is the total amountcoming into the business for sale of goods and services (including sale oftrading stock) and any other amount derived in doing business.In calculating the profits from any business the following amounts areincluded –(a)(b)(c)(d)(e)(f)Service fees.Incoming for trading stock.Gains from realisation of business assets or liabilities.Excess amounts derived in realisation of depreciable assets.Amounts derived as consideration for accepting a restruction on thecapacity to conduct the business.Gifts and ex gratia payments received by the person in respect ofthe business.

(g)Amounts derived that are effectively connected with the businessthat would otherwise be included in calculating the person’s incomefrom investment.The following receipts are excluded from calculating business income –(a) exempt amounts and final withholding payments.(b) amounts that are included in calculating the person’s income fromany employment.0.3 Claim of right to derive income or incur an expenditureFor the purposes of accounting for income tax purposes an amount shallbe treated as derived or expenditure incurred by a person notwithstandingthat the person is not legally entitled to receive the amount or liable tomake the payment. So long as the person claims to be legally entitled toreceive or legally obliged to pay the amount.0.4 Reverse of amountsWhere a person has deducted expenditure in calculating the person’sincome and the person later recovers the expenditure, the person shall, atthe time of recovery, include the amount recovered in calculating theperson’s income. Such reversals include:-Where a person has included an amount in calculating the person’sincome but because of the legal obligation to do so, the person laterrefunds the amount, the person may deduct the amount at the time ofrefund.Where in calculating income on accrual basis a person deductsexpenditure that the person shall be obliged to make and the personlater disclaims an obligation to incur the expenditure the person shall,at the time of disclaimer, include the amount disclaimed in calculatingthe person’s income.Where in calculating income on an accrual basis a person includes anamount to which the person is entitled and the person later disclaimsan entitlement to receive the amount or in the case of a bad debtclaim of the person, the person writes off the debt as bad the personmay, at the time of disclaimer or write off, deduct the amount.0.5 Deductions from business income.

(a)Business expenditure is deductable only when any business iscarried on by the person at any time during the year of income.(b)For the purposes of calculating a person’s income from business forany year of income no deduction shall be allowed for –i) consumption expenditureii) excluded expenditureiii) expenditure incurred by the person in deriving exemptamounts or final withholding paymentsiv) distributions by an entity.(c)For the purposes of calculating a person’s income for a year ofincome from a business, there shall be deducted all expenditureincurred during the year of income by the person, wholly andexclusively in the production of the income.For calculating the income from business, the following deductionsare allowable –i) Interest expense. Interest incurred by a person during a year of incomeunder a debt obligation shall be treated as incurred whollyand exclusively in the production of income from abusiness if the debt obligation was incurred in borrowingmoney employed in the business or to acquire an assetthat is employed during the year of income in theproduction of the income. In any other case, the debtobligation was incurred wholly and exclusively in theproduction of the business income.The total amount of interest that an exempt controlledresident entity may deduct for a year of income shall notexceed the sum of all interest derived by the entity duringthe year of income that is to be included in the entity’stotal income and 70 percent of the entity’s total income forthe year calculated without including any interest derivedor deducting any interest incurred by the entity.

Example 1An exempt-controlled resident company, M Ltd received during year 2004business income of Tshs. 6,000,000 including interest of Tshs. 4,000,000.During the year it incurred interest expenditure of Tshs. 5,000,000. Theallowable interest expenditure for the year 2004 is calculated as follows:-Total business income for the year of income shs. 6,000,000Less interest derived amount (4,000,000) “and interest incurred 5,000,000 “ 1,000,000Balance shs. 7,000,00070% of the balance shs. 4,900,000Add:Interest received 4,000,000Maximum allowable expense shs. 8,900,000Since the maximum allowable interest expense is sh. 8,900,000/= thewhole interest expenditure amount of shs. 5,000,000 can be allowed as adeduction in the year 2004.

Example 2An exempt controlled company K Ltd made during the year business profit of shs.4,000,000 after deducting interest payment of shs. 3,500,000 and inclusive of interestreceipt of shs. 1,000,000. Ltd’s maximum allowable interest expense is calculated asfollows:-Taxable income/(loss) shs. 4,000,000Less Interest earned (1,000,000)Interest incurred 3,500,000 shs. 2,500,000shs. 1,500,00070% of the rest of the income shs. 1,050,000Maximum allowable interest expense is calculated as follows:Interest derived during the year shs. 1,000,00070 percent of company's other income shs. 1,050,000Maximum allowable interest expense shs. 2,050,000K Ltd’s income is adjusted as follows:Income declared shs. 4,000,000Add interest incurred shs. 3,500,000shs. 7,500,000Less maximum interest expense shs. 2,050,000Adjusted income for the year shs. 5,450,000Interest carry forward to following yearTotal interest incurred shs. 3,500,000Less expensed during the year shs. 2,050,000Carry forward interest shs. 1,450,000The interest amount of shs. 1,450,000 denied deduction during the year may be carriedforward and treated as incurred during the next year of income.ii) Trading Stock Allowance.For calculating a person’s business income for a year of income there shallbe deducted trading stock allowance. The allowance is calculated as:The opening value of trading stock of the business for the year of incomeAdd expenditure incurred by the person during the year that is enacted inthe cost of the trading stock.

Deduct the closing value of the trading stock of the business forthe year of income.The closing value of trading stock of a business for a year of income shallbe the lower of the cost of the trading stock of the business at the end ofthe year of income OR the market value of the trading stock of thebusiness at the end of the year. When the closing value of the tradingstock is determined on the basis of the market value the cost of thetrading stock shall be reset to that value.ExampleThe trading stock position of company J Ltd as at the end of the year ofincome is shown in the Trading Account as follows:Opening Stock shs. 15,000,000Purchases and cost’s “ 60,000,000shs. 75,000,000Closing stock “ 30,000,000Cost of sales shs. 45,000,000However, at the end of the year the market value of the stock isdetermined to be shs. 22,000,000.J Ltd’s trading stock allowance is determined as follows:Original trading stock allowanceOpening stock shs. 15,000,000Add Purchases and cost “ 60,000,000shs. 75,000,000Less Closing stock shs. 30,000,000Trading stock allowance shs. 45,000,000Revised trading stock allowanceSince the closing stock value is adjusted at market value the adjustedstock allowance is reset as:Opening stock value shs. 15,000,000Add Purchases and cost “ 60,000,000shs. 75,000,000Less revalued closing stock shs. 22,000,000

Adjusted Trading Stock allowance shs. 53,000,000The trading stock allowance for the year of income is taken as shs.53,000,000 and not shs. 45,000,000. Note that the opening stock valuefor the next year of income will now be shs. 22,000,000 and not shs.30,000,000.iii) Repair and Maintenance expenditure.For the purposes of calculating a person’s income for a year of income from anybusiness, these shall be calculated all expenditure to the extent incurred deriving the yearof income by the person and in respect of the repair and maintenance of depreciableassets owned and employed by the person wholly and exclusively in the production ofthe person’s income from the business. Note that no deduction shall be allowed forexpenditure in improving an asset, which may be included in the cost of the asset andallowed either in calculating gains or losses on realisation or depreciation allowances.iv) Agriculture, research, development andenvironmental expenditures.For the purposes of calculating a person’s income from business for anyyear of income expenditure on agricultural improvement, research anddevelopment and environmental expenditure to the extent incurred whollyand exclusively in the production of the income from the business shall beallowed.Agricultural improvement expenditureFor the purposes of the deduction “agricultural improvement expenditure”means expenditure incurred by the owner or occupier of farm land inconducting agriculture, livestock farming or fish farming business wherethe expenditure is incurred on clearing the land and excavating irrigationchannels or planting perennial crops or trees bearing crops.Environmental expenditure“Environmental expenditure” means expenditure incurred by the owner offarmland for the privention of soil erosion or in connection with newdyingany damage caused by natural resource extraction operations to thesurface of or environment on land. Where in conducting a resourceextraction business a person makes a provision for any expenditure inconnection with remedying any damage caused by the resource extractionthe Commissioner may, in writing, subject to such terms and conditions asthe Commissioner thinks and for the purpose of the deduction only, treatthe provision as environmental expenditure incurred in conducting thebusiness.

Research and development expenditure“Research and development expenditure” means expenditure incurred inthe process of developing the person’s business and improving businessproducts or process and includes expenditure incurred by a company forthe purposes of an initial public offer and first listing on the Dar es SalaamStock Exchange. However, the expenditure excludes any expenditureincurred that is otherwise included in the cost of any asset used in anysuch process, including an asset consisting expenditure incurred by aperson in the person’s business in respect of natural resource prospecting,exploration and development.Terms and conditions for Commissioner’s approval of a provision forenvironmental expenditureIn approving a provision for environmental expenditure to be allowed as adeduction incurred a person the Commissioner shall specify a date bywhich the expenditure must be incurred by the person, which date shallnot be more than two years after the date by which resource extractionhas substantially ceased.Where the Commissioner approves the provision and the person does notincur the expenditure by the specified time the Commissioner shall adjustany assessment of the person so as to remove the deduction, whichadjustment will be made irrespective of the time limit for making anassessment. The person shall be liable for interest for under estimatingthe tax payable by instalment and interest for failure to pay tax. Theperson shall also be liable for penalty for making false or misleadingstatement calculated as though the person made, without reasonableexcuse, a statement to the Commissioner in claiming the deduction thatwas false or misleading in a material particular.v) Gifts to public and charitable institutions.For the purposes of calculating income from a business amountscontributed during the year of income to a charitable institution or socialdevelopment project or deduction made under section 12 of the EducationFund Act, 2001 shall be deducted. The available deduction in respect of adeduction other than a donation made under the Education Fund Act,2001, shall be capped at 2 percent of the person’s income from businesscalculated without the deduction.vi) Depreciation Allowances for Depreciable Assets.Depreciation Allowances are allowed in respect of depreciable assets. Adepreciable asset is an asset employed wholly and exclusively in theproduction of income of a business, which was or benefit to the businesslasting more than one year, and which is likely to lose value because of

wear and tear, obsolescence or the passing of time. Land, shares andtrading stock are excluded. Depreciable assets include machinery,vehicles, equipment, buildings, frameworks and legal rights which expire(leases, franchise). When a person purchases and starts using adepreciable asset, or makes an improvement to a depreciable asset, theperson cannot deduct the full amount of the expenditure in the first year,except for agriculture and mining business assets, but can deduct portionsof the expenditure for a number of years until the full expenditure hasbeen deducted. The deduction system can be straight line method orreducing balance method. The conditions for entitlement of depreciationallowances deduction are that the asset should be owned by the personand the asset should actually be used wholly and exclusively in theproduction of the income.vii) Losses on realisation of business assets andliabilities.In calculating a person’s income for any year of income from any businessfrom the following realisations shall be allowed –Business asset of the business that was employed wholly andexclusively in the production of the income from the business;a debt obligation incurred in borrowing money which was employed oran asset purchased with the money is or was employed wholly andexclusively in the production of the income; ora liability of the business other than a debt obligation incurred isborrowing money, where the liability was incurred wholly andexclusively in the production of the income from the business.viii) Losses from a business.For calculating the income of a person from business other than theincome of a partnership or a foreign permanent establishment, anyunrelieved loss of the year of income of the person from any otherbusiness and any unrelieved loss of a previous year of income of theperson from business shall be deducted.Foreign source losses shall be deducted only in calculating the person’sforeign source income.Where a person calculates income for a year of income from more thanone business of the person and deducts an unrelieved loss in more thanone such calculation, the person may choose the calculation orcalculations in which the loss or part of the loss is deducted.

ix) Capital losses.Capital losses are calculated for other “business assets”. Other “businessassets” are assets which are used as part of a person’s business but arenot trading stock and they are not depreciable assets. The followingassets are excluded from business assets and are therefore not liable forinclusion in capital loss calculations:-If a trading individual, an interest in land that has a market value ofless than shillings 10 million at the time it is sold and that has beenused for agricultural purposes for at least two of the three years priorto sale.In case of a resident corporation, shares in another residentcorporation in which the first resident corporation holds more than 25percent of the shares.Shares and securities listed on the Dar es Salaam Stock Exchange.Capital losses may be made when a person realises (sells) an asset. Whena person makes a capital loss from the sale of other business assets theperson may deduct the loss from the person’s income from business.x) Carry forward losses.If a person made a loss from the person’s business in the previous year,the loss can be carried forward and deducted from the current year’sbusiness income. Losses can be carried forward this year from year toyear indefinitely. However loss carry forward is subject to the followinglimitations:-(a)(b)(c)Limits on losses of corporationsIf a corporation is sold (at least 50% of the underlying ownershipchanges) than losses made by it before the sale cannot be used tooffset its income after the sale. The exception is where for a periodof two years after the change the corporation conducts no businessother than that conducted at any time during the twelve monthperiod before the change.Limits on capital lossesIf a corporation makes a loss when selling a business asset, it canoffset only gains from selling other business assets.Foreign losses

Foreign business losses can offset only foreign business income,losses on the sale of foreign business assets can offset only gainson sale of foreign business assets.Example.A corporation C Ltd made during the year of income 01 investment loss ofsh. 1,200,000 and business loss of Tsh. 2,800,000. During the year 02 thecorporation made Investment gain of shs. 4,200,000 and business profitsof sh. 2,000,000. The corporation’s taxable income from business andinvestment in year 02 will be calculated as follows:-Investment incomeInvestment gain shs. 4,200,000Less Loss carry forward from year 01 “ 1,200,000Net gain shs. 3,000,000Business incomeProfit from business shs. 2,000,000Business loss carried forward “ (2,800,000)Net business loss carry forward to year 03 shs. (800,000)xi)Bad debtDeduction is allowed for the purposes of calculating income of a personfrom any business in respect of any debt or part thereof which hasbecome bad or irrecoverable during the year of income subject to thefollowing conditions.In the case of a debt claim of a financial institution, only after theclaim has become bad debt as determined in accordance with therelevant standards established by the Bank of Tanzania.In any other case, only after the person has taken all reasonable stepsin pursuing payment and the person reasonably believes that the debtclaim will not be satisfied.The debt must have been included in calculating the person’s incomefor the year of income.The debt must have been written off as irrecoverable in the books ofaccounts of the person for that year of income in which the debt isclaimed to have become bad.Taxable income of C Ltd for the year 02 is as follows:-Investment income shs. 3,000,000

Business loss “ 800,000C Ltd will pay tax on investment profits of shs. 3,000,000 and carryforward business loss of shs. 800,000 to year 03.